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November 28, 2006 Dear Colleagues:

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November 28, 2006 Dear Colleagues:

  1. 1. November 28, 2006 Dear Colleagues: I would like to thank the Asset Manager Forum for allowing JPMorgan to participate in the Corporate Action Processing Best Practices initiative. Corporate events processing remains a key business challenge for the industry and we at JPMorgan believe it is important to expedite standardization to improve the timing, accuracy, STP and risk reduction of these transactions. A detailed response for each best practice recommendation follows on pages 2-19 as well as additional recommendations for consideration. In addition to the detailed responses, I would like to summarize the JPMorgan perspective on the document as a whole: • The document is detailed and exposes key issues affecting the industry as told from a U.S. market Investment Manager perspective. JPMorgan recommends that the reviewer audience be expanded to include all markets to expedite a single global market practice. • Some recommendations call for custodians to assume responsibility for issuer & agent information quality and/or scrubbing tasks. JPMorgan recommends that the industry launch a concerted effort to inform and address issues directly with the data source, as they will be better equipped to understand and resolve the problem. • The investment manager community plays a crucial role in the corporate action process. JPMorgan recommends that all custodians and asset managers work together to create a more balanced process benefiting all parties in the industry. • The current securities market practice for corporate action announcement, instruction, response, status and payment confirmation allows substantial room for interpretation. JPMorgan recommends that the industry produce a single, exacting security market practice for corporate actions which eliminates risk and enables STP. Once again, we are grateful for the invitation to contribute to this important initiative and look forward to working with the AMF on paving the way forward. Best Regards, Barbara Lubey JPMorgan Worldwide Securities Services Global Custody Product Management 212.552.0182
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  3. 3. JPMorgan Response to AMF Best Practices document for Corporate Action Processing 1.1. Receiving Initial Information Custodians receive the initial corporate action information from many different sources and in many different formats from issuers, depositories, data vendors and other sources. Standardization of this information is needed. There are currently at- source standardization efforts being led by DTCC, ISITC and SMPG in the U.S. In Europe there are harmonization efforts underway and many industry organizations are working jointly. The goal is to receive the data from the source, i.e. the issuer, in a standardized format. Until this happens, the current process will remain. Data will continue to be received from multiple sources and it must be cross checked for accuracy. Custodians and asset managers will continue to manage different deadlines by sub-custodian and custodian and the risk of missed or incorrect information will remain. Best Practice Recommendations: 1. Custodians should use at least two sources for corporate actions information when available. These sources should be cross checked for accuracy. Prospectus should be used as the primary source when available. JPMorgan supports the recommendation when there are at least two sources available. We further recommend: • Form a panel of industry firms to review the quality of data provided by all sources. • Issue a discussion report highlighting areas of opportunity for information enhancement. • Review findings individually with sources and determine next steps. 2. Market participants should follow the market guidelines and standards set out by the national market group (in the U.S. ISITC) for Corporate Actions. ISITC has published market practice guidelines for the announcement of a corporate action. Custodians should look to these market practice guidelines and use recommended codes for each action type so that formats would be standard across the industry. JPMorgan supports this recommendation for adherence to market practice globally. We further recommend: • All industry participants adhere to the guidelines and standards to ensure STP and consistency for announcements, instructions, responses, status and payment confirmations. 1.2. Terms 3
  4. 4. Industry participants should capture the meaning of terms related to corporate actions to ensure that all players are using the same and correct terms. Also review DTCC’s draft event matrix to ensure that it conforms. Best Practice recommendation: All parties should follow the globally harmonized Event Interpretation Grid 1 and other such harmonized documents. JPMorgan supports this recommendation where practical. We believe the industry should adopt one “dictionary” of corporate action terms which should be used globally across all markets to eliminate interpretation and technology costs. 1.3. Information Received from Custodians 1.3.1. Prospectus For asset managers, there is no need for receiving prospectuses for 144A issues. For other issues, prospectuses may be needed, particularly in the case of complicated offers, to ensure full and accurate information about the issue. Most asset managers do not require prospectuses as part of the general corporate actions information flow from custodians, and not many custodians provide the prospectuses as part of that flow. However, where prospectuses are desired, both asset managers and custodians prefer electronic delivery. Manually distributing prospectuses is a time consuming process that should be eliminated across the board. Usually, custodians do not receive hard copy prospectus as a general course of information flow, and if a prospectus is provided, it is not in an electronic format. In the U.S., for actions registered with the SEC, most prospectuses can be retrieved on the internet from the EDGAR database. A best practice recommendation that would require a custodian to obtain and distribute prospectuses to all clients would actually move away from STP and create additional time to perform the necessary data distribution process, thus efforts should be focused on having “internet links” available to asset managers requiring this information. Such “links” could be provided electronically thus keeping with the spirit of STP. Another area of focus would be to ensure that issuers provide such links at time of announcement regardless of whether an offer is registered with the SEC. Prospectuses outside of the U.S. are somewhat problematic. For example, in France there is a rule that prohibits prospectus delivery to the U.S., which poses challenges to custodians. Another challenge is the language barrier as a prospectus is usually written in the language of the country where the security is registered. The Committee also supports efforts to standardize information in offering documents. The key attributes (see section titled: Complete Announcement) should be stated in a clear standardized format upfront in the prospectus. Best Practice Recommendations: 1. Eliminate the dissemination of prospectuses for 144A issues. 1 Event Interpretation Grid: http://www.smpg.info, under Documents, 2) Corporate Action, A. Final Global Documents, Event Interpretation Grid v 4.0. 4
  5. 5. JPMorgan supports the elimination of manual or labor intensive practices where appropriate; however, JPMorgan will continue to provide prospectus material for assets subject to voluntary events when made available by Issuers & Agents to be used by clients and investment managers as they deem appropriate. We further recommend: • 144a exchange offers be changed to exchange with option to retain. This will have the effect of reversing the industry default from take no action to exchange bonds for unrestricted bonds. • Form a panel of industry firms to recommend this approach with issuers, agents, and the DTCC. • Issue a discussion report highlighting the need and benefit of instituting the recommendation. • Meet with issuers, agents and the DTCC to determine next steps and timeframes. 2. For all other issues, when the asset manager requires prospectus material, it should be distributed by the custodian to the asset manager in a standard electronic format (a pdf file) or via an electronic link to a prospectus available on the internet. The AMF supports efforts to standardize electronic prospectuses and encourages issuers to provide prospectuses in the standardized electronic format. In the interim, until full electronic delivery can be realized, custodians are only required to distribute prospectuses when the electronic formats are available. JPMorgan supports the distribution of prospectus information electronically and have partnered with vendors to develop and offer this capability. However, JPMorgan will continue to provide hard copy prospectus material for assets subject to voluntary events when made available by Issuers & Agents to be used by clients and investment managers as they deem appropriate. 1.3.2. Instructions and other supporting information received from custodians Asset managers prefer to receive instructions from custodians via automated electronic format or SWIFT (ISO protocol) messages. Using the standardized formats for corporate actions information is essential. Many custodians offer web based applications, but the asset managers are slow to adopt these systems because they are proprietary and may be non-standardized. Other supporting documentation, in addition to a prospectus, should also be distributed electronically from custodian to asset manager. Again, the SEC’s EDGAR database contains information for SEC registered issues. There may also be issuer web sites for non-registered corporate actions which may be utilized for information dissemination. There are also vendor solutions available to get supporting information. (See the list of vendors in Exhibit 1.) The asset manager may also need other market information, such as pricing information and reference data, prior to making a decision relating to a voluntary corporate action. 5
  6. 6. Best Practice Recommendation: The custodian should send market information to the asset manager in a standardized electronic format and it should be stated upfront in the offering document. The corporate action needs to be clear and understandable. Asset managers in turn would have to educate their analysts and portfolio managers on the use of the electronic systems and standards for market information. (See also section titled: Complete Announcement.) JPMorgan supports this recommendation where practical. We believe the industry should adopt one electronic standard format and rule book for market data which should be used globally across all markets to eliminate interpretation and technology costs to make this recommendation truly effective. We further recommend: • Form a panel of industry firms to review the format and distribution medium of market data provided by issuers and agents. • Issue a discussion report highlighting areas of opportunity for standardization and electronic information distribution. • Review findings individually with issuers and agents and determine next steps. 1.4. Complete Announcement of Voluntary Corporate Actions 1.4.1. Timing of preliminary notice – timeliness vs. accuracy Custodians struggle with the question of when is the best time to send the first notice. Is it immediately when the news comes out, even if the facts are incomplete, or when there is more verified information available? Custodians use news services to receive information on corporate actions, and then verify the information to create a golden copy of the action. Many times the details of the corporate action change after the first instance of news about it. Some asset managers want to receive the information about an upcoming corporate action event immediately, whereas others prefer to receive the more complete and verified information. Custodians may have to send the information to all their clients, if it is being sent to one. This is a service-level agreement issue and should be defined in the agreement with each client. JPMorgan concurs and recommend that the timing options available for announcements are standardized. 1.4.2. Complete Announcement The asset managers would like to receive standardized information from custodians to ensure that critical data is covered upon which the asset manager’s investment team can base their decisions. The items below are the minimum required data elements of a corporate action announcement. (There may be additional data attributes important to a particular corporate actions event.) Best Practice Recommendation: Key data attributes for announcements as standard data requirements: 6
  7. 7. Security Identifier (such as CUSIP/ISIN) Security Description Custodian Deadline Tender Deadline Consent Deadline Consent Details Market Expiration Date Rates Method of payment (cash or stock or both) Supporting documentation that is required (e.g. proof of being a QIB) Restrictions Proration New Identifiers (exchange to new CUSIP or what is the new issue) Expected Pay Date or Effective Date JPMorgan supports this recommendation where practical. The two chief causes of missing key data elements stem from either the nature of the event itself or the lack of information receipt by the issuer/agent. In the former case, provision should be made to exclude key data elements from the announcement standard. In the latter case, We further recommend: • Form a panel of industry firms to review the recommendation versus the current level of market data provided by issuers and agents. • Issue a discussion report highlighting areas of opportunity for information enhancement. • Review findings individually with issuers and agents and recommend service level requirements. 1.5. Election Communications Custodians do have web based applications for voting purposes, but asset managers find multiple systems cumbersome and the multiple proprietary systems make standardization more difficult. Best Practice Recommendation: Custodians should standardize communications to asset managers for elections including accurate reflection on election options. Ultimately, the industry needs to standardize the election options across all actions. JPMorgan recognizes that Investment Managers would prefer a single product rather than a proprietary system and supports the recommendation to standardize communications. JPMorgan offers a full suite of market practice compliant SWIFT messages which may be used for all parties to a transaction. In addition, a web based workstation is available for non SWIFT clients. In addition, JPMorgan supports the recommendation to standardize election options across all actions and welcomes the opportunity to drive this initiative 7
  8. 8. forward with the investment management community through securities market practice. 1.6. Mergers and Acquisitions Getting information on mandatory corporate actions in a timely manner is sometimes problematic, especially on mergers and acquisitions on equities, where the initial notification includes only an indicative timeframe for the effective date (such as 1st quarter). The asset manager cannot process the action until the date is known. This poses challenges to asset restrictions for trading etc. The effective date may be communicated at the last minute, or after the fact, whereas the asset manager needs to have the asset available for trading in their system under the new name on the effective date. Best Practice Recommendations: 1. Require timely notification upon completion of merger/acquisition. 2. Issuers and issuers’ agents should communicate the effective date five days prior to the effective date. JPMorgan supports the recommendation to standardize notification timeframes for certain events and welcomes the opportunity to drive this initiative forward with the investment management community. We further recommend: • Form a panel of industry firms to review the current timeframes in practice provided by issuers and agents. • Issue a discussion report highlighting areas of opportunity for improved timings and the risk inherent in the processing deadlines. • Review findings individually with issuers and agents and recommend service level requirements. 1.7. Partial Calls On partial calls, the most pressing issue is timely receipt of information for partial calls. Publication dates have frequently passed when the asset manager receives the information. The asset manager relies heavily on custodial information and some custodians do not provide the information on a timely basis, nor is the information format consistent between custodians. Custodians in turn rely on DTCC for the partial call information. Timeliness of lottery results and being able to restrict the asset from trading is also an issue. Best Practice Recommendation: Require notification upon receipt of lottery results. JPMorgan supports the recommendation to standardize notification timeframes for lottery results. 8
  9. 9. We further recommend: • Form a panel of industry firms to review the current timeframes in practice provided by depositories, issuers and agents. • Issue a discussion report highlighting areas of opportunity for improved timings and the risk inherent in the processing deadlines. • Review findings individually with depositories, issuers and agents and recommend service level requirements. 1.8. Assets on Loan – Securities Lending Determining entitlements on assets on loan should be a transparent process between the custodian and the asset manager. Some custodians are fully transparent and show all positions that have been loaned, on the other hand, there are some custodians who handle securities lending in a non-transparent manner. Sometimes it may even be challenging for the custodian’s corporate action team to determine that an asset is loaned, based on systems functions. There are also third party lending programs which may not be transparent to either the custodian or the asset manager. Thus the asset manager’s corporate actions team may not be aware that the particular asset has been given out for lending. Some asset managers do not track which assets are on loan, nor do they know which accounts lend positions. When the corporate action notice is received from the custodian, the asset manager needs to confirm client positions with all custodians to develop the entitlement by client and by custodian. The custodian is required to send a 180 letter to the borrowing broker 24 hours prior to the expiration date to protect the client’s entitlement on the asset on loan. Reconciliation and payment matching are sometimes also hampered due to systems shortfalls in this area. Increased or more accurate communication on loan products is needed. The ISO protocol messages could possibly include a loan position and settled- settled position. Asset managers would like to receive the complete entitlement notices on both mandatory and voluntary actions, and these notices need to indicate when the distributions are expected to be distributed (payment date). Some asset managers use dealer managers on “Dutch auctions” hence they do not have to recall stock loans as the asset manager commits to the dealer manager the amount of securities to be submitted. Best Practice Recommendations: 1. Improve communications relating to assets on loan. 2. Best practices need to be developed for notification, as custodians should send asset managers the complete entitlement notice including payment date. 3. Best practice guidelines are needed for entitlement calculations. Standard entitlement calculations should be adopted by custodians for settled and on-loan entitlements. JPMorgan supports the recommendation to standardize entitlement processing and welcomes the opportunity to drive this initiative forward with the investment management community through securities market practice. 1.9. Corporate Actions on Derivatives and Options 9
  10. 10. As the options and derivatives marketplaces have exploded in the past few years, asset managers find that there are many more corporate actions affecting these instruments. For example, an asset manager may be holding an option as the parent company is going through a stock split. The contract needs to be adjusted to reflect the stock split and the corporate action needs to be initiated on the option. Most custodians do not provide a separate corporate action notice on the option or the OTC derivative contract. As asset managers handle more volume in OTC derivatives, these issues are becoming more commonplace and a best practice guideline is needed to advise how to process the corporate action. There are also related custody and accounting issues, as well as downstream valuation issues. Some asset managers run queries on all corporate actions events on equities to see whether an event has an impact on a security that is embedded in an option. However, not all options are similarly affected by corporate actions because at times the contract will get adjusted but at other times the factor will get adjusted. Best Practice Recommendation: The AMF Corporate Actions Committee recognizes that there is a need to enhance processing of derivatives and options related corporate actions. Ongoing research and comments from the industry are needed to determine a best practice recommendation. Entitlements related to collateral pledges also need to be considered for best practices. JPMorgan supports the recommendation to research and construct a market and best practice for derivatives and options related corporate actions and collateral pledge entitlements. The market/best practice should take into account which parties are best positioned to monitor/maintain the link between the contract as well as the associated underlying securities. 1.10. Accounting Issues Accounting issues impact some but not all participants involved in the corporate action process. Areas that can and should be focused on from an industry perspective would be to ensure consistency in having timely issuer provided information, availability of data sources for non-U.S. based securities and an agreement on industry-accepted default treatments for certain action types. Asset managers need timely and accurate information in order to post to the client accounting records. Currently, custodians use the record date for a corporate action as the eligibility date but that may not be the effective date of when the price adjusts in the marketplace. Thus custodians should communicate at least two fields to ensure accurate accounting, cost basis and effective date. These fields need to be communicated particularly for mandatory actions. It should also be noted that as other aspects of the corporate action process improve, such as DTCC’s re-engineering project, some of the timing and consistency issues will improve. Best Practice Recommendation: In connection with mandatory actions, custodians should strive to provide to the asset manager an accurate effective date as soon as it is known. If possible, the cost basis can be provided using an entitlement message (ISO15022 or other form of messaging). 10
  11. 11. JPMorgan supports the recommendation to standardize data requirements and timeframes for corporate action effective dates. We further recommend: • Form a panel of industry firms to review the current dates and timeframes in practice provided by depositories, issuers and agents. • Issue a discussion report highlighting areas of opportunity for improved dates, timings and the risk inherent in missing/late information. • Review findings individually with depositories, issuers and agents and recommend service level requirements. 1.11. Proration Proration takes place when there are not enough shares to satisfy the offers tendered by shareholders and a proportion of cash and shares is granted for each offer tendered. One of the pain points for asset managers is that the proration rates are not announced early enough in the process. Each offer is different and market value at the time of the offer has major impact on the proration. If one offer is over-tendered, the purchaser needs to decide whether they want to take the extra shares or not, depending on the market value at the time. If the purchaser takes all the shares, then no proration factor is involved. Many times proration is not announced until after the corporate action has taken place, which essentially locks up all the shares. However, asset managers also need to manage account limitations on contract provisions for various holdings. Some clients may indicate in their indentures that the asset manager may not hold equity or other type of securities for the client. In these cases, when there is an equity distribution on a corporate action, the asset manager tries to sell the rest of the shares as soon as the proration rates are announced. Thus, asset managers would prefer to learn the proration rates sooner so that they can decide what to do with the unaccepted shares. To mitigate this problem, some custodians use pre-announcements, however, as the information in the pre-announcements is preliminary information, it may not be completely accurate but is instead indicative. This may also cause problems for the asset manager as the asset manager’s expectations are not in line with what the custodian eventually posts. Best Practice Recommendation: Custodians should strive to find out the timing of the proration announcement sooner and then distribute to asset managers the finalized terms immediately when known. JPMorgan supports the recommendation to standardize notification timeframe requirements for proration announcement terms. We further recommend: 11
  12. 12. • Form a panel of industry firms to review the current timeframes in practice provided by offerers, issuers and agents. • Issue a discussion report highlighting areas of opportunity for improved timings and the risk inherent in late information. • Review findings individually with offerers, issuers and agents and recommend service level requirements 1.12. Rounding There is currently no uniformity among custodians relating to how the proration rates are applied at the client level. Custodians may round differently even when the clients have the same ratio of shares. Oftentimes it is the agent for the offer that decides how to apply rounding, i.e., whether to round up, down, or at all. These agent rounding rules are distributed to custodians via the DTCC re-org feed. Custodians submit shares for the tender to DTCC, but they may also have to submit a physical piece directly to the agent, which obviously need to be in sync. Asset managers confirm with their custodians how accounts are rounded. This is done manually, usually over the phone. Going forward, custodians should announce at the time of the payment how proration factor was applied and how rounding worked. It would be helpful to all parties if the proration factor was mandated, i.e. whether to round up or down. That way, when the entitlement rate comes out, the allocation is clear and asset managers would know what has been tendered. Best Practice Recommendations: 1. Custodians should announce, using an entitlement message, the proration factor, whether rounding was used, and whether the rounding was up or down for a particular event. 2. The industry should also pursue ways to implement an overall industry guideline on rounding on a country level. 3. For fractional shares entitlements the custodians should announce at event level how fractional shares are carried and ultimately sold off. JPMorgan supports the recommendation to research and construct a market and best practice for rounding which is practical for all industry participants. 1.13. Portfolio Manager’s Needs vs. Processing Requirements One of the pain points from the portfolio manager’s perspective is the timing of the announcement. Custodians may take too long to create the “golden copy” of the corporate action event, or wait until information is finalized in the final announcement of the action, which may create a short window of time to respond. Sometimes the response deadline may be less than a day. Particularly on complex scenarios, asset managers need more time to respond. Custodians may be pushed to request response very quickly after information is being sent, especially on international issues where sub-custodians are providing the original information. Particularly, relating to Brady Bonds’ Dutch Auctions, the foreign press release announcement on which the asset manager would base their decision, is not made until the actual date of expiration, which prevents the asset manager from making the election by the custodian deadline. 12
  13. 13. Best Practice Recommendations: 1. Press local markets to announce information sooner. This issue needs to be raised with agents and issuers. 2. The industry should also adopt a standard set of data attributes that constitute the “golden copy” of an event. JPMorgan supports the recommendation to standardize and improve notification information requirements and timeframes for announcements. We further recommend: • Form a panel of industry firms to review the current information requirements and timeframes in practice provided by depositories, issuers and agents. • Issue a discussion report highlighting areas of opportunity for improved information requirements and timings and the risk inherent in the processing deadlines. • Review findings individually with depositories, issuers and agents and recommend service level requirements. 1.14. Response Deadlines Typically the late or non-responses occur on complicated late priced issues where the asset manager may not know how to respond because market conditions are difficult. Asset Managers may be waiting on pricing information before making an investment decision on a corporate action. The delay in the decision making process puts a significant burden on the custodian’s operational process that needs to take place in order to execute the action. The industry issue is whether this risk is inherent investment risk related to the particular security, or whether it is an operational and processing risk. For each corporate action type there are inherent deadlines that need to be adhered to. In order to cut down on the operational risk, these investment decision deadlines should be well known in advance. However, while the committee acknowledges the inherent risks with response deadlines, after further review and discussion, it was agreed that no recommendation can be made at the event level as such. It is felt that each custodian creates a competitive advantage by allowing ever shorter response deadlines. To a certain extent, this can be SLA driven. However, as a general guideline, the committee would advocate that the response deadline date for all event types should be the DTCC expiration date minus 2 days. For global corporate actions the response deadline should be 2 days prior to the deadline imposed by downstream market intermediaries, which may be a foreign sub-custodian or international depository. Best Practice Recommendation: For domestic corporate actions, the general response deadline for all event types should be DTCC expiration date minus 2 days. For global corporate 13
  14. 14. actions the general response deadline should be 2 days prior to the international sub-custodian or depository. JPMorgan supports the recommendation to standardize response deadlines for event types where this is feasible. We further recommend: • Form a panel of industry firms to review the current response deadlines in effect by event type. • Issue a discussion report highlighting areas of opportunity for improved deadlines taking into consideration issuer/agent instruction execution requirements. • Review findings individually with depositories, issuers and agents and recommend new response deadline requirements. 1.15. Tracking Deadlines Tracking deadlines for accounts’ response to corporate actions is a challenge to asset managers. Some asset managers have a corporate actions system that tracks the deadlines, while others perform tracking manually. Custodians may also send reminders to asset managers (expiration date minus 3) to respond by the deadline day. If the industry would follow the above recommendation and use the standard guideline for response deadline of expiration date minus 2, the tracking of deadlines between custodians would become much easier. However, for some action types, there might still be differing deadlines. Best Practice Recommendation: Use the general response deadline of expiration date minus 2 where possible. JPMorgan supports the recommendation as stated in section 1.14. 1.16. Payment in Kind (PIK) Distribution Practices There is a need to harmonize market practices of various custodians holding PIK paying securities. Market values for some PIK securities can be thousands of dollars per bond making the reconciliation process vital to the corporate actions process. The Corporate Actions Committee recommends asset managers to use dual security setup to reflect the best possible recordkeeping process. The setup incorporates two separate securities to reflect the client’s entire holdings, the whole share line and the fractional share line (4 decimal place system). The fractions are maintained on an in- house “CUSIP” identifier. This procedure enables a firm to keep an updated and accurate holding record when applying the PIK payments from stock dividends to the ex-date positions. Once fractional line equals one whole share, they are transferred to the whole share line, in turn; fractions received from the whole share line, due to stock dividends, are transferred to the fractional share ”CUSIP” identifier. Both the fractional line and whole share line accrue additional entitlements. DTCC reflects these PIK securities in a dual security setup, using an in-house “CUSIP/ISIN” identifier to reflect the balances in multiples of 100,000. Many custodians use the same in-house “CUSIP/ISIN” identifier to reflect the balances on their book, making the in house “CUSIP/ISIN” identifier practically a market identifier. 14
  15. 15. Note: The dual security setup may be altered by DTCC once they decommission the contra CUSIP, as PIK securities are often paid in a “dummy” number at DTCC for recordkeeping purposes only. Best Practice Recommendation: Use dual security setup to reflect the best possible record keeping process. JPMorgan supports and complies currently with this recommendation. 1.17. Process Issues If fractional holdings are sold by issuer or DTCC the above process is not applicable. Custodian may automatically sell all fractional shares (SLA driven). Not all custodian systems may allow for 4 decimal places, which results in rounding differences. Some PIK securities may not fit into this model and will require special handling and processing. This process requires constant review to ensure fractions are transferred to whole share ”CUSIP” identifier in a timely manner. Using a 4 decimal system allows for better control and reconciliation of the various position structures between the custodians, while maintaining an up to date value for the portfolio trading and accounting systems. 1.18. International Issues Custodians have challenges to capture corporate action information timely and accurately outside the U.S. market. Custodians may be more dependent on the local sub-custodians, and the information may not be in a format suitable for U.S. It is assumed that most custodians would have service level agreement with local sub- custodians requiring them to be SWIFT compliant. In the U.S. DTCC may not always provide information in a standard format. As the industry around the globe continues to evolve and harmonize the way corporate actions are announced and processed, both custodians and asset managers will see progress, but at this point there is no best practice that can be recommended. 1.19. Staff Education and Training Relating to Corporate Actions Content Some corporate actions are very complex and require that the asset managers’ staff understands what is involved in different types of corporate actions. The information includes legalese, and key pieces of information may be buried in non-standardized and non-formatted data. It is important to understand which accounts are restricted and which are qualified to participate and on what level. It is also important to know the requirements on QIB Letters. It is assumed that both custodian and asset manager staff will receive a base-level education relating to corporate actions, but there are complex issues that require continuing education follow-up as the corporate actions environment changes. It is the responsibility of each organization to ensure that training is taking place to mitigate dissatisfaction of clients and operational losses that may occur due to lack of training. There are a number of formalized training opportunities available, such as the program offered by the Institute of Certified Bankers which has a designation and 15
  16. 16. testing for certified securities operations professionals. The Securities Operations Forum also provides training classes on corporate actions. 2. Automation of Corporate Actions Process Flow with ISO15022 Messaging The ISO15022 standards for securities messaging, in conjunction with market practice guidelines, provide a standard and protocol that can support more automated information exchange in corporate actions processing. The standards provide for a group of messages designed to facilitate the full life-cycle of the corporate action process between agents, custodians and asset managers. The point of origination for the information flow in this example is the issuer’s agent or central securities depository. In an optimized flow, the original event notification will already be in ISO15022 format. This will help ensure that all parties along the communication chain are sharing the same data elements that describe the event, for example, the same elective options, the same corporate action identifier, etc. In some markets, especially the US, the depository is not generally the primary data source for the event announcement. Account Servicers (custodians) in the U.S. market 16
  17. 17. tend to use data providers. In the past these data providers utilized proprietary formats to disseminate event information. When the custodians built the “golden copy” of the event from the data provided, i.e., the most accurate representation of the event based on their data sources, they would then translate it to ISO15022 format. In order to steer the data providers to the more standardized ISO15022 formats, a Market Data Provider User Group was formed in 2004, and now most vendors offer the option to receive the data in ISO15022 format. Once the custodian has complete information of an upcoming event, they send a “complete” announcement to the Account Owner (asset manager). When there are choices or elections associated with the event, the asset manager will elect and then build a message to respond to the custodian. In this response, if the asset manager responds using the same identifiers for the event, and especially the same elective options, the custodian has a much better chance of being able to automatically process the response. Another impediment to automated processing in the exchange of information between custodians and asset managers is the use of narrative text. Since only data within structured fields can be processed automatically, most systems will disallow STP for messages with narrative text. They will, instead, route the message to a referral queue, so a human can evaluate and process the information that is in narrative form. The remaining messages in the process flow are the processing status and advice, to automatically notify an Account Owner of the status of his election, and the confirmation that tells the Account Owner that the securities and/or cash resulting from a corporate action have settled in the account. 3. ISO15022 Corporate Actions Messages The following are the messages available for corporate actions processing: • MT564 – Corporate Action Notification. Used to provide an Account Owner with the details of a corporate action event along with the possible elections or choices available to the Account Owner. The notification can be sent as a preliminary notification, a finalized notification, or an updated notification. • MT565 – Corporate Action Instruction. Message used to supply an Account Servicer with instructions on how the Account Owner wishes to proceed with a corporate action event. • MT566 – Corporate Action Confirmation. Message is used to confirm to an Account Owner that securities and/or cash have been credited or debited to an account as the result of a corporate action. • MT567 – Corporate Action Status and Processing Advice. Message is used to advise the status, or change in status, of a corporate-action related transaction previously instructed by, or executed on behalf of the Account Owner. • MT568 – Corporate Action Narrative. Message is used to provide complex instructions or narrative details relating to a corporate action event. 17
  18. 18. 4. Message Usage and Market Practice The use and exchange of these messages between custodians and asset managers, especially message processing flows that can be characterized as STP are still in an early stage of development and certainly not as prevalent as with trade-related messages. There are several reasons for this. One important factor is the complexity of corporate actions. There are dozens of codes that represent the type of corporate action, and within each type of corporate action there can be multiple elections for an asset manager. Another factor that has slowed standardization and automation is market practice. For many event types, there are market specific rules. There are extensive efforts underway within the industry to document and harmonize market practice, most notably the Securities Market Practice Group (SMPG) facilitated by SWIFT (www.smpg.info). Also of note is the value-added validation that is provided by SWIFTNet for these messages. SWIFTNet FIN validation ensures that syntax, codes and qualifiers are compliant with the current standards. Even with field and syntax compliance, because of the flexibility of the standard, there is a need to provide event-specific and market- specific best-practice standards for the industry to follow. These are being developed by the SMPG, which has recently published the Event Interpretation Grid (EIG). The EIG is a guide to the best practice standards for event notification by event type, across many markets. Recently SWIFT has begun to develop a Testing and Certification service that will test whether counterparties are actually SMPG-compliant. Finally, another large impediment to greater levels of automation for the industry is the financial risk inherent in the processing of corporate actions. When processing is automated, there is no comfort level of human oversight to prevent misinterpretation of instructions. There was a similar impediment to STP processing for trade settlements with the prevalent use of narrative text, in the not so distant past. This was overcome through the introduction of ISO15022 standards which provide for structured, standardized data field usage. The same evolution is underway for corporate actions, but the road to full acceptance is fraught with the difficulties and the risks already described. Through the various market practice groups and industry initiatives, such as The Asset Managers Forum Corporate Actions Best Practices initiative, the industry will continue to move toward greater levels of automation in the corporate actions process, as standardized automation is ultimately the best way to mitigate risk and streamline costs. 5. DTCC Reengineering Project DTCC is currently in the process of reengineering its corporate action system. The corporate action reengineering project was undertaken to replace the legacy systems and old technology, affording a foundation for standardization of events. One of the compelling benefits of the new system is that it supports industry standard messaging in the form of ISO 15022 messaging standards for announcements, instructions, entitlements and payments. This provides an opportunity for DTCC participants to use the DTCC option numbering scheme that can result in additional standardization in the market place. 6. Benefits to the Industry The Corporate Actions Committee’s proposed industry-wide best practices relate to all corporate actions events, covering capital change events, income and principal 18
  19. 19. payment events and mergers and acquisitions. These best practices also cover multiple markets and instrument types. All industry participants will benefit when the corporate actions processing cycle is automated and standardized. The benefits include a reduction in operational (and financial) risk associated with corporate actions, increase in efficiency when automated systems can handle increasing corporate actions volume with less human contact, and eventually cost savings when standardization and automation will afford the organization’s resources to be used in other areas. 7. Exhibits 1. AMF Corporate Actions Committee 2. Reference List of Vendors 3. Asset Manager Corporate Actions Process 4. Custodian Corporate Actions Process 19

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